In July 2009 the SEC released proposed changes to Proxy Disclosure rules to, (in addition to other goals) “enhance the compensation and corporate governance disclosures registrants are required to make about… potential conflicts of interest of compensation consultants that advise companies.”
The SEC invited public comment with a deadline for submission of mid-September, 2009. Well over 100 comments have been surfaced on the SEC’s web site to date among them, of course, are letters from consulting firms: Watson Wyatt, Towers Perrin, Pearl Meyer, Deloitte Consulting, Buck Consultants, and Grahall, among many others. (To peruse the list and read the letters click here.) For a summary of Grahall’s letter to the SEC click here .
Without a doubt, the issue of conflict of interest is of paramount concern to consulting firms, and particularly to multi-service firms such as Watson Wyatt, Towers Perrin, Mercer and Hewitt (the “Big 4”, if you will, of that genre). In its September 15, 2009 letter to the SEC (click here to read), Watson Wyatt has outlined a clever way to minimize the perceived impact of conflict of interest and “joins with three other multi-service human resources consulting firms (Towers Perrin, Mercer and Hewitt Associates) in making this recommendation”. They suggest that the disclosure requirement for fees paid by a client for whom executive compensations consulting services are provided be compared to TOTAL FIRM REVENUES, unless this amount does not meet a certain threshold (less than .05% is proposed as teh threshold for non-disclosure). Let’s be sure to remember that these firms are the biggest of the big multi-service firms. With, most certainly, the largest overall firm revenues, and that with the new-year two of these giants will merge to become Towers Watson, the single largest multi-service firm with revenues in excess of $3 billion.
Based on their proposed disclosure rules, the new Towers Watson clients would need to disclose total fees paid to the merged entity only if those fees exceeded $1.5 million per year (.05% of $3 billion)! Would it create a conflict if a firm was paid over $1.5 million per year by an executive compensation client? Well, possibly or possibly not, but $1.5 million is, by any measure, a lot of “interest” if you get my drift.
The other interesting aspect of this proposal is that it is completely blind to how consultants are motivated and compensated. In most cases, consultants are compensated based on their “book of business”. That is the revenue collected from the clients they serve. Growing this book of business is key to the success of the enterprise and therefore key to the success of the individual consultant. Some small part of a consultant’s overall pay maybe based on the “consolidated gross revenues”, for example, “consolidated firm revenues” may influence stock price and therefore the value of stock options for a publically traded firm such as Towers Watson. A consultant is motivated, compensated and potentially conflicted not by how much his clients’ fees relate to the firms’ consolidated gross revenues, but rather how much his clients’ fees relate to his personal book of business.
The average senior compensation consultant would likely have a practice of $2,000,000 and would be working on clients that provided $10,000,000 to $20,000,000 of revenues to the firm for “other” services. The average executive compensation client would provide $100,000 or 5% of the executive compensation consultant’s book fo business (i.e. revenues), but this same client provides 10 to 20 times that revenue to the firm.
Let’s look at a simple example: I am a consultant at Big One Consultants, Inc. We provide executive compensation work for publically traded Company X with fees for these services of $100,000 per year. Company X is one of 20 clients of mine each with revenues of about $100,000 making my total book of business $2,000,000. Big One Consultants, Inc. also provides other consulting services to Company X garnering additional fees of $1,000,000. Company X is one of 5 clients managed by CRM (client relationship managers) John Slick. John’s total book of business (including Company X) is $10,000,000 in revenues. Company X represents 5% of my book of business and 10% of John Slick’s. But when compared to total firm revenues, let’s say those are $3 billion, Company X total fees paid to Big One Consultants represents only .037% of the firms gross revenues, not nearly enough to register as far as the “Big 4” recommended disclosure requirements go.
But the real questions are 1) where does the potential for conflict arise and 2) where would a conflict occur? This is the level at which revenues should be disclosed. From our point of view, with many years in the consulting business, in large firms, small firms, multi-service firms and boutiques we know that the potential for conflict arises with consultant based on his or her client revenues compared to his or her own book of business. This is the level at which disclosure should occur.
As a “side bar” to this discussion it is also true that these “Big 4″ and other multi-service consulting firms (Hay comes to mind) hold themselves out as experts in motivating talent. Some of these consultants register over 30 years of experience in the talent management /motivation arena. With this background, we don’t buy that they don’t buy that there is no conflict of interest below a threashold of total firm revenues. We think these multi-service firms “doth protest too much”. If they truly believe that there no conflict of interest, then why would they not agree to disclose fees on every level.
Consultants can argue that one study trumps or refutes another one. They can argue all day that the 2007 Wharton School study (see The Role and Effect of Compensation Consultants on CEO Pay, by Brian Cadman, The Wharton School, Northwestern University, Mary Ellen Carter, The Wharton School and Stephen Hillegeist, INSEAD) or the 2008 Mashall School study (see Executive Pay and “Independent” Compensation Consultants, Kevin J. Murphy, Marshall School of Business, University of Southern California, Tatiana Sandino, Leventhal School of Accounting, Marshall School of Business, University of Southern California, June 20, 2008) are “better” or more accurate than the 2007 Waxman study . But does it really matter?
In the conclusion to the Wharton School Study mentioned above, the authors state that “Little is known about the influence of compensation consultants on executive pay. Understanding the influence of consultants has become an important question as the use of compensation consultants by boards of directors has risen…”
And the Marshall Study referenced above admits that “Compensation consultants can never be truly independent from the executives who hire them, since the consultants will naturally seek to secure repeat business and ‘cross-sell’ additional services.”
The 2007 Waxman report shares that it “…did not investigate the internal practices in place within compensation consulting firms, such as efforts to separate executive pay consultants from the firm’s other engagements with a client company. However, there is evidence to suggest that the lines between those providing executive compensation advice and those providing other services may not be as bright as the consultants described.”
Doesn’t all of this suggest the critical need to disclose all fees at all levels, which are received by consultancies from executive compensation clients? Clearly the multi-service firms are worried about the proposed disclosure rules and are trying their damnedest to avoid the appearance of a conflict. From where they sit, fee disclosure will only fuel concerns about conflicts so, obviously, we know where they stand.
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